Impairment (financial reporting)

An investment is recognized as impaired when there is no longer reasonable assurance that the future cash flows associated with it will be collected either in their entirety or when due. Entities look for evidence of situations that would indicate impairment. Such triggering events include when the entity[11] –

• is experiencing notable financial difficulties,
• has defaulted on or is late making interest payments or principal payments,
• is likely to undergo a major financial reorganization or enter bankruptcy, or
• is in a market that is experiencing significant negative economic change.

If such evidence exists, the next step is to estimate the recoverable amount of investments. The impairment cost would then be calculated as follows:

${\displaystyle {\mbox{Impairment Cost}}={{\mbox{Recoverable Amount}}-{\mbox{Carrying Value}}}}$

The carrying value is defined as the value of the asset appearing on the balance sheet. The recoverable amount is the higher of either the asset's future value[12] for the company or the amount it can be sold for, minus any transaction costs.[13][14]

Estimates of future cash flows used to determine the present value of an investment are made on a continuous basis and do not rely on a triggering event to occur. Even though there may be no objective evidence that an impairment loss has been incurred, revised cash flow projections may indicate changes in credit risk. These revised expected cash flows are discounted at the same effective interest rate used when the instrument was first acquired, therefore retaining a cost-based measurement. Calculating the impairment cost is the same as under the Incurred Loss Model.

For example, assume a company has an investment in Company A bonds with a carrying amount of $37,500. If their market value falls to $33,000, an impairment loss of $4,500 is indicated and the impairment cost calculated as follows:

${\displaystyle \$37500-\$33000=\$4500}$

This is recorded as a loss of $4,500 in the income statement. Using the 'T' account system, there will be a debit in the Loss on Impairment account and a credit in the Investment account. This will mean the double-entry bookkeeping principle is satisfied.

Debit: Loss on Impairment $4,500

Credit: Investment $4,500[15]

To calculate depreciation on the asset, the new non-current asset value is considered. Continuing with the previous example and using the Straight line Depreciation method at say, 20%, depreciation would be:

${\displaystyle \$33000\cdot 0.2=\$6600}$

The depreciation charge is smaller than if the original non-current asset value had been used.

Reversal of impairment losses is required for investments in debt instruments, but no reversal is permitted under IFRS for any impairment changes recognized in net income for equity instruments accounted for in OCI; however, subsequent changes in the equity investment's fair value are recognized in OCI.